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Business Cycle: Definition and 6 Stages

The economy of every country undergoes periodic fluctuations. Although they are repetitive, it is impossible to avoid them .

Many factors cause these fluctuations, such as GDP, employment, consumer spending, real income, production, and aggregate output.

Smart business owners and policymakers study these economic cycles and patterns to help them make informed financial decisions. Preparing for these periodic fluctuations ensures your business thrives even in unstable economic conditions.

This article explains the workings and stages of the business cycle.

Let’s get started.

Definition and Example of the Business Cycle

The business cycle, otherwise known as the economic cycle or trade cycle, is a term that depicts the increase or decrease in economic activities involving production, trade, and consumption over time.

In other words, a business cycle involves expansions occurring simultaneously in multiple economic activities followed by recessions (general contractions).

Business cycles help measure the downward and upward movement of the amount of productivity of businesses, employees, and consumers alongside the growth cycle of the economy over time.

As the Gross Domestic Product (GDP) fluctuates around its natural long-term growth rate, economic cycles help explain the expansion and contraction phenomena that characterize an economy over time.

Example of the Business Cycle

Every business cycle must have passed at least a single boom and a single contraction sequentially.

In recent decades, major economies and businesses have increased their production level. It has led to the need for more employees and has translated to less spending money. As a result, companies make more profits that help them focus on growth.

In the reverse case, when the economy is slow, there is a decline in the number of employees needed, which translates to a decrease in consumer spending. As a result, companies have less focus on growth.

To fully understand the business cycle, you need to understand two key terms: economic expansion and contraction.

Economic expansion in economic analysis is the rate at which production and consumption change positively, while economic contraction is inversely the rate at which production and consumption change negatively.

The United States as a Case Study

In the United States, for example, the end and start of a business cycle are defined and measured by the National Bureau of Economic Research (NBER), a non-profit business cycle dating committee.

The NBER uses quarterly GDP growth rates to determine the current business or economic cycle. It waits till it gets enough economic data to prevent a situation where it would have to make revisions to the business cycle chronology.

Businesses are affected by the expansion and contraction of the economy as they also go through their own distinct set of ups and downs in their trade cycle.

This situation puts the management of the business in a position to devise strategic financial decisions to deal with these challenges head-on. Understanding the time of the business cycle helps businesses make correct investment decisions.

6 Stages of the Business Cycle

The business cycle illustrates how a nation's aggregate economy moves over time, showing ups and downs.

Business cycles are characterized by economic expansions followed by sustained periods of economic recessions. In a business cycle diagram, the straight line is the steady growth line, and every business cycle moves about the line.

All business cycles pass through six distinct identical phases.

1. Expansion Stage

The first stage in every business cycle is the expansion phase. Expansion begins when there is a visible increase in positive economic indicators such as employment, demand, and supply of goods and services, wages, profits, personal income, national income, and output.

Economic expansion is a period of relative growth in a nation's economy. During this phase, productivity increases, as visible as an upward movement in the yield curve.

The economic recovery phase is another name for the expansion stage. It occurs after an economy has been through a contraction for an extended period.

This phase is characterized by debtors paying off their debts on time, high velocity of money supply, and high investments. It continues as long as the economic conditions remain favorable.

GDP growth is the economic measurement index that indicates economic output increase during the expansion phase. When economic output rises, businesses and organizations hire more workers and open up more strategic business units .

The goal of the federal reserve bank during the expansion phase is to keep inflation around 2% for a healthy economy.

During this stage, the stock market also experiences rising prices as investors grow in confidence, businesses receive more funding, and consumer confidence is at an all-time high.

The expansion phase is close to its end or overheating state when the economy begins to grow too fast, which is visible in the employment rate emerging below the natural rate and inflation increasing with stock prices rising to the point of being overvalued.

A country experiences a healthy expansion when the GDP growth rate is in the 2 – 3% range, inflation maintains its 2% target, and the unemployment rate is between 3.5 – 4.5%, with the stock market supporting a bullish run.

2. Peak Stage

The saturation point or peak an economy reaches is the second stage of the business cycle. It is visible by the economic indicator's inability to grow further as it has attained its maximum growth limit.

During the peak phase, prices are at their highest, marking the reversal point in the trend of economic growth as consumers tend to make changes to their budget structure.

At the peak phase, all expansionary indicators begin to level as the economy prepares to transition into the contraction or recession phase.

The peak is visible graphically as the highest portion of the yield curve before the economy begins to experience a downward spiral characterized by a continuous decline in GDP growth below the 2% healthy mark.

Once the nation's economic numbers start growing out of their healthy ranges, the economy is most vulnerable as any factors can throw it off balance at this stage.

Companies expanding recklessly, overconfident investors, buying up of assets, and a significant price increase not supported by their underlying value are several factors that can throw the country's economy off balance in the peak stage.

With no room left for growth and nowhere to go but down, the economy falls into the recession or contraction phase after it has reached the peak and end of the expansion phase. It indicates that prices and production have reached their respective limits.

3. Recession or Contraction Stage

The recession stage comes after the peak phase and is evident by a rapid and steady decline in the demand for goods and services.

Producers in the economy do not readily notice this rapid and steady decline as they go about their regular daily production numbers. Thus creating a situation of excess supply in the market which tends to bring down prices abruptly.

Apart from prices, other positive economic indicators also witness a significant fall, such as income, wages, and output.

A recession graphically spans the time from the peak to the trough, as it is the period when economic activity is at its lowest.

During the recession, unemployment numbers rise, the stock market enters a bearish trend, and the GDP growth is below the 2% healthy value, forcing businesses to cut back on their economic activities.

For an economy to be in recession, the GDP has to have shown a significant decline for two consecutive quarters. It does not return to its original shape and size immediately after the recession phase is over.

4. Depression Stage

After the contraction phase, the nation's economy experiences a significant rise in unemployment across all facets of the economy.

Besides the increase in unemployment, there is also a decline in the growth index for the country's economy, as is evident in its fall below the steady growth line. At this stage of the nation's economy, the country is in its depression stage.

5. Trough Stage

The trough stage is the fifth phase of the business cycle. It is characterized by a decrease in the rate of adverse change in the nation's declining GDP until it eventually turns positive.

In economic terms, a trough represents the negative saturation point for an economy as there is an extensive depletion of national income and expenditure during this stage of the business cycle.

This phase begins when the nation's economy transitions from its contraction phase into its expansion and is represented graphically as the lowest point of the yield curve.

The rebound experienced during the trough phase is not always straight or quick as it continues steadily until the economy reaches full economic recovery.

6. Recovery Stage

After the through phase, a nation's economy enters the recovery stage. This stage is characterized by a significant turnaround in the country's economy, evident by its recovery from its negative growth rate.

Due to prices at their lowest point, demand starts to witness an increase. Consequently, supply and industrial production increase as the population's attitude toward investment and employment is now positive.

During the recovery phase, employment also begins to rise as the accumulated cash balances with the bankers make lending show positives.

Depreciated capital is readily replaced, providing unique opportunities for investment in the production process, which continues until the nation's economy returns to steady growth.

Economic Indicators for Measuring the Business Cycle

Economic indicators used to measure the productivity of a business cycle are very extensive as they are based on financial data of the nation's economy.

Here are the three common categories of economic business cycle indicators.

1. Leading Business Cycle Indicators

A leading business cycle indicator measures aggregate economic activity and predict a business cycle's beginning phase.

The leading business cycle indicators are the average weekly work hours in manufacturing, stock prices, factory orders of goods, index of customer expectations, average weekly claims for unemployment insurance, interest rate spread, and housing permits.

Usually, changing these indicator metrics could significantly point towards a potential shift in the business cycle. Leading economic cycle indicators get the most attention due to their tendency to predict a shift in advance of a business cycle.

These indicators work best alongside coincident and lagging indicators in the same framework. They provide a more thorough understanding of the true nature of economic activity.

2. Lagging Business Cycle Indicators

Lagging economic cycle indicators are designed as confirmatory indicators, confirming the trends predicted by leading indicators. Generally, lagging indicators usually experience a significant shift witnessed after an economy has entered a period of fluctuation.

The average length of employment, labor cost per unit of manufacturing output, consumer price index, commercial lending activity, and average prime rate are all lagging indicators components.

3. Coincident Business Cycle Indicators

Coincidental economic cycle indicators measure the aggregate economic activity that is subject to changes as the business cycle progresses.

As one of the three components of economic business cycle indicators, coincident cycle indicators are economic research tools that help measure the real income of consumers in the market, among other factors.

The unemployment rate, personal finance levels, and industrial production are index components for coincident business cycle indicators.

How is the Business Cycle Influenced?

The fact that periodic business cycles move in phases does not mean they cannot be influenced. Countries can manage the various stages of a business cycle through monetary and fiscal policies.

1. Government Legislations

Generally, the government monitors the business cycle and devises a series of legislations to influence their country's business cycle, primarily around changes in tax and spending.

The government's fiscal policy is designed to increase taxes and reduce spending during an economic expansion, lower taxes and increase spending during an economic contraction. This policy is called the expansionary fiscal policy.

2. Monetary Policy

The Fed and the country's central bank use monetary policy tools that help implement needed changes to the country's interest rates.

This policy helps curtain lending and borrowing by businesses, banks, and consumers and influences the business cycle through rates that target inflation and unemployment.

When the country has slipped from its expansionary phase into a contraction phase, the central bank lowers its target interest rates to encourage borrowing in a request to end the contraction phase.

This policy by the central bank is termed an expansionary monetary policy. It is configured to be the turning point that pushes the business cycle back into the expansionary phase.

In unique situations, when a country's economy is growing faster than the country can afford, the central bank of such a country steps in. It offers preventive measures to contain the fast-growing economy.

The nation's central bank raises its target interest rates to discourage borrowing and spending, curbing the growth of the nation's economy.

This policy by the central bank is termed a contractionary monetary policy as its main aim is to contract economic activity spread and economic output to contain the economic expansion.

Business Cycle FAQ

No defined time frame exists for how long a business cycle should last. It varies from being short for months to being long, lasting several years.  According to the U.S Government National Bureau of Economic Research, the time frame average for business cycles in America to play out is around five and a half years since World War II.  Periods of expansion are generally more prolonged than those of contractions. As observed since WWII by the Congressional Research Service, the economic expansion period lasted 65 months on average, while the financial contraction period lasted about 11 months in the U.S. 

Ranging from technological innovations to wars, a wide variety of factors can shape the business cycle. According to the Congressional Research Service, the critical influence remains on aggregate demand and aggregate supply within an economy. Contraction occurs when demand decreases and when demand increases, expansion occurs. 

The economic expansion that occurred between 2009-2020 in the U.S went down in history as the longest expansion and the latest for a record 128 months. The U.S reached the peak of this longest expansion in February 2020. It was characterized by many variables in an economy fluctuating over time, leading to a shift in economic and non-economic factors.

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What Is a Business Cycle?

• How It Works
• Measuring and Dating
• Relationship With Stock Prices

The Bottom Line

Business cycle: what it is, how to measure it, and its 4 phases.

• Depression in the Economy: Definition and Example
• Economic Collapse
• Business Cycle CURRENT ARTICLE
• Boom And Bust Cycle
• Negative Growth
• What Was the Great Depression?
• Were There Any Periods of Major Deflation in U.S. History?
• The Greatest Generation
• U.S. Government Financial Bailouts
• Austerity: When the Government Tightens Its Belt
• The New Deal
• The Economic Effects of the New Deal
• Gold Reserve Act of 1934
• Emergency Banking Act of 1933

Madelyn Goodnight / Investopedia

Business cycles are a type of fluctuation found in the aggregate economic activity of a nation—a cycle that consists of expansions occurring at about the same time in many economic activities, followed by similarly general contractions. This sequence of changes is recurrent but not periodic.

The business cycle is also called the economic cycle .

Key Takeaways

• Business cycles are composed of concerted cyclical upswings and downswings in the broad measures of economic activity—output, employment, income, and sales.
• The alternating phases of the business cycle are expansions and contractions.
• Contractions often lead to recessions, but the entire phase isn't always a recession.
• Recessions often start at the peak of the business cycle—when an expansion ends—and end at the trough of the business cycle, when the next expansion begins.
• The severity of a recession is measured by the three Ds: depth, diffusion, and duration.

Understanding the Business Cycle

In essence, business cycles are marked by the alternation of the phases of expansion and contraction in aggregate economic activity and the co-movement among economic variables in each phase of the cycle.

Aggregate economic activity is represented by not only real (i.e., inflation-adjusted) GDP —a measure of aggregate output—but also the aggregate measures of industrial production, employment, income, and sales, which are the key coincident economic indicators used for the official determination of U.S. business cycle peak and trough dates.

Popular misconceptions are that the contractionary phase is a recession and that two consecutive quarters of decline in real GDP (an informal rule of thumb) means a recession.

It's important to note that recessions occur during contractions but are not always the entire contractionary phase. Also, consecutive declines in real GDP are one of the indicators used by the NBER, but it is not the definition the organization uses to determine recessionary periods.

On the flip side, a business cycle recovery begins when that recessionary vicious cycle reverses and becomes a virtuous cycle, with rising output triggering job gains, rising incomes, and increasing sales that feedback into a further rise in output .

The recovery can persist and result in a sustained economic expansion only if it becomes self-feeding, which is ensured by this domino effect driving the diffusion of the revival across the economy.

Of course, the stock market is not the economy. Therefore, the business cycle should not be confused with market cycles , which are measured using broad stock price indices.

Measuring and Dating Business Cycles

The severity of a recession is measured by the three D's: depth, diffusion, and duration. A recession's depth is determined by the magnitude of the peak-to-trough decline in the broad measures of output, employment, income, and sales.

Its diffusion is measured by the extent of its spread across economic activities, industries, and geographical regions. Its duration is determined by the time interval between the peak and the trough.

An expansion begins at the trough (or bottom) of a business cycle and continues until the next peak, while a recession starts at that peak and continues until the following trough.

The National Bureau of Economic Research (NBER) determines the business cycle chronology—the start and end dates of recessions and expansions for the United States.

Accordingly, its Business Cycle Dating Committee considers a recession to be "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales."

The Great Depression featured many recessions, one of which lasted for 44 months.

The Dating Committee typically determines recession start and end dates long after the fact. For instance, after the end of the 2007–09 recession, it "waited to make its decision until revisions in the National Income and Product Accounts [were] released on July 30 and Aug. 27, 2010," and announced the June 2009 recession end date on Sept. 20, 2010.

U.S. expansions have lasted longer than U.S. contractions on average. Between 1945 and 2019, the average expansion lasted about 65 months. The average recession lasted approximately 11 months.

Between the 1850s and World War II, the average expansion lasted about 26 months and the average recession about 21 months. The longest expansion was from 2009 to 2020, which lasted 128 months.

Stock Prices and the Business Cycle

The biggest stock price downturns tend to occur—but not always—around business cycle downturns (e.g., contractions and recessions). For example, the Dow Jones Industrial Average and the S&P 500 took steep dives during the Great Recession. The Dow fell 51.1%, and the S&P 500 fell 56.8% between Oct. 9, 2007 to March 9, 2009.

There are many reasons for this, but primarily, it is because businesses assume defensive measures and investor confidence falls during contractionary periods. Many events occur before people in an economy are aware they are in a contraction, but the stock market trails what is going on in the economy.

So, if there is speculation or rumors about a recession, mass layoffs , rising unemployment, decreasing output, or other indications, businesses and investors begin to fear a recession and act accordingly. Businesses assume defensive tactics, reducing their workforces and budgeting for an environment of falling revenues.

Investors flee to investments "known" to preserve capital, demand for expansionary investments falls, and stock prices drop.

It's important to remember that while stock prices tend to fall during economic contractions, the phase does not cause stock prices to fall—fear of a recession causes them to fall.

What Are the Stages of the Business Cycle?

In general, the business cycle consists of four distinct phases: expansion, peak, contraction, and trough.

What Does a Business Cycle Describe?

A business cycle describes the fluctuations in an economy over a period of time, generally the period from the start of one recession to the start of the next. This would include periods when the economy grows.

Are Business Cycles Predictable?

Generally, business cycles are not predictable. Economies are complex machines that function in a variety of ways and are intertwined in as many ways. The ability to predict how they will move is extremely difficult. There can be signs of changes in an economy, such as changes in inflation and production, but to predict an all-out change in the business cycle is very tough if not impossible.

The business cycle is the time it takes the economy to go through all four phases of the cycle: expansion, peak, contraction, and trough. Expansions are times of increasing profits for businesses, and rising economic output, and are the phase the U.S. economy spends the most time in. Contractions are times of decreasing profits and lower output and are the phase in which the least amount of time is spent.

Federal Reserve Bank of St. Louis. " All About the Business Cycle: Where Do Recessions Come From? "

The National Bureau of Economic Research. " Business Cycle Dating ."

National Bureau of Economic Research. " The NBER's Recession Dating Procedure ."

Congressional Research Service. " Introduction to U.S. Economy: The Business Cycle and Growth ," Page 1.

National Bureau of Economic Research. " Business Cycle Dating Committee, National Bureau of Economic Research ."

Congressional Research Service. " Introduction to U.S. Economy: The Business Cycle and Growth ," Page 2.

Federal Reserve Bank of Atlanta. " Stock Prices in the Financial Crisis ."

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A Survey on Business Cycles: History, Theory and Empirical Findings

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• First Online: 14 April 2023
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• Giuseppe Orlando   ORCID: orcid.org/0000-0003-2630-5403 5 , 6 &
• Mario Sportelli   ORCID: orcid.org/0000-0003-1999-7632 6  

Part of the book series: Springer Proceedings in Business and Economics ((SPBE))

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• X Euro-Asian Symposium on Economic Theory "Viability of Economic Theories: through Order and Chaos"

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This work summarizes recent advances in modelling and econometrics for alternative directions in macroeconomics and cycle theories. Starting from the definition of a cycle and continuing with a historical overview, some basic nonlinear models of the business cycle are introduced. Furthermore, some dynamic stochastic models of general equilibrium (DSGE) and autoregressive models are considered. Advances are then provided in recent applications to economics such as recurrence quantification analysis and numerical tools borrowed from other scientific fields such as physics and engineering. The aim is to embolden interdisciplinary research in the direction of the study of business cycles and related control techniques to broaden the tools available to policymakers.

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Orlando, G., Sportelli, M. (2023). A Survey on Business Cycles: History, Theory and Empirical Findings. In: Kumar, V., Kuzmin, E., Zhang, WB., Lavrikova, Y. (eds) Consequences of Social Transformation for Economic Theory. EASET 2022. Springer Proceedings in Business and Economics. Springer, Cham. https://doi.org/10.1007/978-3-031-27785-6_2

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Morris Mthombeni and Albert Wocke

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At the end of last year, Dan Marokane became the 12th chief executive of Eskom in the past decade alone. He returned to the embattled South African state-owned utility monopoly, which he had left in 2015, to tackle the tensions between fixing the company to ensure energy security in South Africa and meeting its “just energy transition” commitments to lower emissions.

At COP26, the UN Climate Change Conference in Glasgow, in December 2021, the US, EU, UK, France and Germany pledged $8.5bn to help South Africa shut its coal-fired powered stations. Eskom generates more than 90 per cent of electricity used in South Africa and the Southern African Development Community region, of which 85 per cent is produced from fossil fuels.

Overall, the energy sector contributes 41 per cent of South Africa’s CO₂ emissions, according to the World Bank , earning Eskom the dubious honour of being called “the world’s worst polluting power company” by some environmental groups. Eskom also finds itself at odds with climate activists and academics such as those from University College London and the International Institute for Sustainable Development, who argue that “no more fossil fuel projects are needed as renewable energy sources take up the demand”.

In addition, since 2008, Eskom has struggled with debilitating national blackouts euphemistically known as “load shedding”. These were caused by insufficient generation to meet demand for power as a result of poor management, corruption and bad political decisions. Electricity prices spiked and the lack of power further weakened the South African economy, costing as much as £40mn per day.

The authors

Morris Mthombeni and Albert Wocke are professors at the Gordon Institute of Business Science at the University of Pretoria in South Africa; Professor Mthombeni is also dean at Gibs

During the first half of 2024, the situation appeared finally to be stabilising, following the appointment of Mteto Nyati as Eskom chairman. Nyati had a successful track record in the technology and telecommunication sectors. Marokane, as a new chief executive with a supportive board chair, is also able to draw on his prior experience at Eskom, when he was in charge of generation.

Marokane has cautioned that, while there has been no load shedding for several months, “South Africa is not out of the woods yet”. His strategy includes carrying out extensive maintenance at underperforming coal-fired power stations that had been poorly maintained, and dismissing corrupt or incompetent managers. The turnaround is complicated by a new business model and the need for Eskom to move to cleaner energy production as part of the just transition programme.

Eskom was a vertically integrated business since its inception in 1923 but, in 2019, the South African government began a process of unbundling the company into separate subsidiaries for generation, transmission and distribution. The objective was to tackle the problems that led to load shedding and improve efficiency and transparency, reduce rent seeking, and protect capital providers interests.

The first division to be spun off in July this year was transmission, now an Eskom subsidiary known as the National Transmission Company South Africa, which operates with a separate board and management team. This has the potential to be the most profitable of the subsidiaries and will run the transmission system and buy electricity from multiple generators, not only Eskom. It will eventually provide a platform for generators, consumers, retailers and traders to trade with each other, as happens in a number of other countries. But Marokane might want to push back the timing of the spin-off for two related reasons.

First, Eskom ought to protect its less profitable generation division, currently dominated by fossil-fuel energy sources. In July, Eskom spoke out against government plans to issue licences allowing private generators to sell directly to customers, and to permit the import of energy into South Africa. The company was concerned that applicants would be able to cherry-pick customers, leaving existing small users without the present cross-subsidy from larger consumers.

Second, to meet its carbon emission reduction targets, Eskom must find a way to address a continuing reliance on fossil fuels as the main source of energy in its generation division. The company had pledged at COP26 to reduce emissions from 442mn tons a year to between 350mn and 420mn tons by 2030. Retaining transmission capability within Eskom could help support a sustainable restructure, leading to a better funded just transition plan.

Marokane was confident Eskom would reduce about 71mn tons of CO₂ from generation by 2030, as it aggressively built a renewable energy portfolio. Yet it has failed to repurpose its 63-year-old 1,000MW Komati power station, east of Pretoria — it was finally decommissioned in October 2022.

Owing to the social consequences of the loss of hundreds of jobs at the fossil-fuelled Komati, which were replaced by many fewer focusing on social entrepreneurship initiatives, Marokane described it as an “ atomic bomb scenario in terms of social discord”.

Despite partnering with the South African Renewable Energy Technology Centre and the Global Energy Alliance for People and Planet to redeploy the hundreds of people who lost jobs after the closure of Komati, Eskom has found that the path to a just energy transition is not a smooth one.

Discussion points

See the FT video above, and:

ft.com/eskom-case1

ft.com/eskon-case2

Considering the current strategy to unbundle Eskom into generation, distribution and transmission subsidiaries, how can the company make its generation business comfortably profitable?

Is the organisational restructure a crucial part of Eskom’s plan to achieve its emission reduction targets? If Eskom believed the restructure was unnecessary for it achieve its 2030 emissions reduction targets, could Marokane and his team consider retaining the current structure for the foreseeable future?

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